Growing concerns on debt sustainability in some developing economies and LDCs


SDG indicators
SDG target 17.4: Assist developing countries in attaining long-term debt sustainability through coordinated policies aimed at fostering debt financing, debt relief and debt restructuring, as appropriate, and address the external debt of highly indebted poor countries to reduce debt distress.
SDG indicator 17.4.1: Debt service as a proportion of exports of goods and services (Tier I)

Debt is a key component of any financing strategy for governments and private firms, particularly from the point of view of long-term financing strategies for sustainable development and structural transformation. The most important criterion for the long-term sustainability of debt obligations is that borrowing serves the purpose of increasing productive investment. If this is the case, increases in domestic income and export earnings are expected to cover the servicing of outstanding debt obligations, given the average interest rate and maturity of the debt stock. A second key criterion for long and short-term debt sustainability concerns the contractual conditions of (re-)financing such debt. The more closely lending conditionalities are aligned to the objective of mobilizing debt finance for structural transformation in developing countries, the higher the chances the debt can be serviced promptly.

However, there is growing concern about debt sustainability in some situations, including in developing economies. A common denominator of rising debt vulnerabilities across developing countries is that, with insufficient international public finance flows and limited access to concessional resources,1 developing countries have increasingly raised development finance on commercial terms in financial markets; they have opened their domestic financial markets to non-resident investors; and they have allowed their citizens and firms to borrow and invest abroad. While increased access to international financial markets can help capital-scarce countries to quickly raise much-needed funds, it also exposes them to the volatility of private financial markets, including to sudden reversals of capital inflows and other risks. In conjunction with other exogenous shocks, such as natural disasters, episodes of political instability or sudden downturns in commodity prices, debt burdens can quickly become unsustainable.

External debt has increased in developing and transition economies, with a growing weight of the private sector

Figure 1 illustrates the upward trend in external long-term debt stocks in developing and transition economies, as well as a marked shift in composition towards private sector debt. Total external long-term debt stocks in these countries almost reached US$5 trillion in 2017, up from US$1.5 trillion in 2000. From 2010, they grew at an average annual rate of 8.4 per cent, outpacing average economic growth in developing countries. Public external debt stocks show an upward trend from 2007, but most of the increase in total external debt stocks is explained by the rapid growth of private sector external debt. While the share of private external long-term debt in developing and transition economies was 27 per cent of total debt in 2000, it increased to around half of total debt since 2008.

Figure 1. Public (PPG) and private (PNG) long-term external debt stocks, developing and transition economies
(Trillions of US$)

Source: UNCTAD calculations based on World Bank (2019).

As seen in figure 2, this pattern of debt composition has been evident in developing South-East Asia and Latin America since 2000, and it has quickly spread to other regions. In most regions, the share of PNG debt in total long-term external debt stocks increased multiple times in the covered period.2 By 2017, non-financial corporate debt in emerging market economies had risen to over US$30 trillion, almost 95 per cent of their combined GDP, surpassing comparable levels for developed markets (Financial Times, 2018). It is difficult for large corporations in developing countries to sufficiently hedge their foreign-currency debt exposure. Their liabilities are, therefore, ultimately backed by foreign currency reserves in their domestic economy. If private sector external debt becomes unsustainable, governments often have no choice but to transfer the bulk of this debt onto public balance sheets.

Figure 2. PPG and PNG long-term external debt stocks, developing and transition economies, by region
(Billions of US$)

Source: UNCTAD calculations based on World Bank (2019).

Increased reliance on commercial finance is not limited to the growing share of private debt stocks. Between 2000 and 2017, the share of PPG external debt in the hands of private creditors rose from just over 40 per cent to above 60 per cent (United Nations, 2018). Also, bond debt now constitutes a large share of PPG developing country debt, having increased from 24 per cent in 2000 to 43 per cent in 2014 (United Nations, 2016). Already by 2016, 46 per cent of all PPG debt of low-income developing countries, twice the rate of 2007, had been financed through non-concessional channels with external borrowing from commercial creditors growing rapidly (IMF, 2018).

Service costs on external debt remains an important challenge for financing sustainable development

Even under favourable financing conditions, an immediate implication of rising debt stocks are higher debt service burdens. Debt service ratios are considered important indicators of a country’s debt sustainability. In this sense, SDG indicator 17.4.1 measures “debt service as a proportion of exports of goods and services”.3 This indicator reflects a government’s ability to meet external creditor claims on the public sector through export revenues. A fall (increase) in this ratio can result from increased (reduced) export earnings, a reduction (increase) in debt servicing costs, or a combination of both. A persistent deterioration of this ratio signals an inability to generate enough foreign exchange to meet obligations on a country’s PPG debt, and thus potential debt distress in the absence of external support or debt restructuring.

By this measure, debt service burdens fell for all developing and transition economies from high levels at the start of the millennium until 2012, when debt service reached 2.7 per cent of exports, before climbing again to 4.2 per cent by 2017 (figure 3). This overall decline can be explained by the rising share of domestic public debt in many economies, as countries sought to address rising costs of sovereign bonds issued in international currencies by shifting to domestic debt in local currency (Micic, 2017). While this reduces the vulnerability to exchange rate volatility, exposure to sudden reversals of capital inflows remains if foreign holding of domestic debt is high. Moreover, this switch frequently creates maturity mismatches, since countries are unable to issue long-term government securities at a sustainable rate of interest, yet need to be able to pay off or roll over maturing and short-term obligations.

Figure 3. Debt service on PPG external long-term debt in developing and transition economies (SDG 17.4.1)
(Percentage of exports of goods and services)

Source: UNCTAD calculations based on World Bank (2019).
Notes: Averages by group of economies. Only countries with available data were included.

As figure 3 also illustrates, the average calculated over all transition and developing economies masks different trends across groups of countries. LDCs dedicated an equivalent of 11.3 per cent of their export revenues to service sovereign external debt in 2000, this figure fell to 3.6 per cent in 2011, but rose to 8.5 per cent in 2016, before falling again to 6.3 per cent in 2017. This reflects rising external public debt stocks since 2012, in a context of volatile commodity prices and high yield increases on international sovereign bonds for some economies in this group. A similarly upward trend in recent debt servicing costs has been observed in SIDS, where this figure increased sharply from 4.7 per cent in 2013 to 10.9 per cent in 2017. In this case, their exposure to natural disasters and the volatility of their main revenue sources are the main explanatory factors. LLDCs, while in general having lower debt servicing costs than the average developing and transition economies, also experienced a marked rise since 2011.

A more worrying picture emerges when the analysis is extended beyond SDG 17.4.1 so that total external long-term debt, including from the private sector, is considered. This provides a more comprehensive picture of debt sustainability. According to this broader measure, shown in figure 4, external debt service burdens for all developing and transition economies fell between 2001 and 2011 from levels close to 20 per cent to 7.7 per cent of exports (except for a one-year increase in 2009 after the global financial crisis). This reflects a combination of factors, including a solid growth performance and growing access to international credit. By contrast, sluggish economic growth following the global financial crisis, rising exposure to market risks and commodity price volatility since 2011, have translated into an upward trend in external debt service. This variable reached 14.7 per cent by 2016. The slight improvement in 2017 can be largely attributed to an upturn in commodity prices.

Figure 4. Debt service on total external long-term debt in developing and transition economies
(Percentage of exports of goods and services)

Source: UNCTAD calculations based on World Bank (2019).
Notes: Averages by group of economies. Only countries with available data were included.

Parallel trends were observed for LDCs. In this case, the faster decline in debt servicing can be attributed to debt relief initiatives by many economies from this group during the late 1990s and early 2000s. While service costs on PPG debts in LLDCs were significantly lower than in the rest of the groups, they become higher when PNG debt is included; this reflects the higher importance of private debt in this group of economies.

For SIDS, external debt service costs remained relatively high throughout the entire period. These costs increased significantly since 2013, highlighting a vicious cycle of high environmental vulnerability and growing structural debt. Many SIDS have recorded a marked increase in their total external debt stocks in recent years, and with this debt service ratios have also surged.

The debt burden in LDCs is of growing concern, since they face the most serious challenges in financing progress along the SDGs. Even if private external debt is also on the increase, these economies still rely predominantly on public debt financing to mobilize resources for long-term structural transformation. Given that these economies are characterized by shallow domestic financial systems and limited access to international financial markets, their options to re-finance maturing debt obligations are limited. Consequently, debt service competes directly for resources with other areas of public expenditure, such as health, education and infrastructure. This risk is presented in figure 5, which shows the median PPG service-to-government revenues ratio in LDCs. The recent upward trend in external public debt stocks induced an increase in debt servicing costs, which increased from 4.1 per cent in 2013 to 7.1 per cent in 2015. Although a gradual decline has been observed in recent years, the service burdens remain high. Further deteriorations could signal unsustainable levels of public debt in these economies. This is a crucial challenge for the timely implementation of the 2030 Agenda in LDCs.

Figure 5. Median ratio of PPG debt service to government revenue in LDCs
(Percentage of government revenues)

Source: UNCTAD calculations based on IMF (2019).
Notes: Only countries with available data are considered.

Notes

  1. For more information on this topic, see Robust and predictable financing sources and Official support for sustainable development.
  2. For additional analysis of external debt stocks trends in developing and transition economies, see United Nations (2018).
  3. According to its official metadata (United Nations, 2019), this indicator includes only service on PPG external long-term debt.

References

  • Financial Times (2018). Upturn in global debt to pile pressure on emerging markets. 11 July.
  • IMF (2014). External Debt Statistics: Guide for Compilers and Users. IMF. Washington, D.C.
  • IMF (2018). Fiscal Monitor April 2018: Capitalizing on Good Times. IMF. Washington, D.C.
  • IMF (2019). Debt sustainability analysis for low-income countries. Available at https://www.imf.org/external/pubs/ft/dsa/lic.aspx (accessed 22 May 2019).
  • Micic K (2017). Recent trends in EME government debt volume and composition. BIS Quarterly Review. September.
  • UNCTAD (2017). Debt Vulnerabilities in Developing Countries: A New Debt Trap? Volume I: Regional and Thematic Analyses. UNCTAD/GDS/MDP/2017/4 (Vol I). Geneva.
  • United Nations (2016). Report of the Secretary-General on external debt sustainability and development. A/71/276. New York. 2 August.
  • United Nations (2018). Report of the Secretary-General on external debt sustainability and development. A/73/180. New York. 16 July.
  • United Nations (2019). SDG indicators: Metadata repository. Available at https://unstats.un.org/sdgs/metadata/ (accessed 14 May 2019).
  • World Bank (2019). International debt statistics. Available at https://databank.worldbank.org/data/source/international-debt-statistics (accessed 22 May 2019).

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